The least risky, senior-most tranches are mainly owned by insurance companies (which favor income-producing investments) as well as banks (which need high-quality capital to meet regulatory requirements). Of the approximately 175 CLO managers 6 with post-crisis deals under management worldwide, PineBridge has found about two-thirds are in the US and the remaining third are in Europe. 5 Who issues, manages, and owns CLOs?ĬLOs are issued and managed by asset managers. Originate from a large, diversified group of issuers.Īs of 30 June 2021, the amount of leveraged bank loans outstanding was $1.26 trillion in the US and €252 billion in Europe. Have a historically high recovery rate in the event of default and Trade in a highly liquid secondary market Pay interest on a consistent monthly or quarterly basis 4 Several characteristics make leveraged loans particularly suitable for securitizations. Standard & Poor’s defines leveraged loans as senior secured bank loans rated BB+ or lower (i.e., below investment grade) or yielding at least 125 basis points above a benchmark interest rate (typically Libor 3 or SOFR in the US and Euribor in Europe) and secured by a first or second lien. Leveraged loans are more than simply the underlying collateral for CLOs: They’re the fuel that powers CLOs’ attractive income streams and the first of several levels of potential risk mitigation built into the CLO structure. Leveraged loans: more than just collateral Source: BofA Merrill Lynch Global Research. 2ĬLOs Get Better With Age US CLO vintages 2.0 and 3.0 represent the biggest share of the market today The market for arbitrage CLOs is valued at $959 billion globally, with about 83% issued in the US and 17% in Europe. The vast majority of CLOs are called “arbitrage CLOs” because they aim to capture the excess spread between the portfolio of leveraged bank loans (assets) and the classes of CLO debt (liabilities), with the equity investors receiving any excess cash flows after the debt investors are paid in full. Vintages 2.0 and 3.0 represent the biggest chunk of the market, with about $800 billion in principal outstanding, while less than 1% of the market remains in CLO 1.0 vintages. To compensate for the exposure to high yield, these CLOs have increased levels of subordination to better protect debt tranches. Currently, few CLOs allow for investments into high yield, and those that do generally limit the exposure to 5%-10%. In 2020, the Volcker Rule was further amended, and high yield bonds are now allowed back into CLOs. The current vintage, CLO 3.0, began in 2014 and aimed to further reduce risk by eliminating high yield bonds and adhering to the Volcker Rule and other new regulations. The next vintage, CLO 2.0, began in 2010 and changed in response to the financial crisis by strengthening credit support and shortening the period in which loan interest and proceeds could be reinvested into additional loans. Commonly known as “CLO 1.0,” this vintage included some high yield bonds, as well as loans, and were the standard CLO structure until the financial crisis struck in 2008. The first vintage of “modern” CLOs – which focused on generating income via cash flows – was issued starting in the mid- to late-1990s. Each CLO is structured as a series of tranches that are interest-paying bonds, along with a small portion of equity.ĬLOs originated in the late 1980s, similar to other types of securitizations, as a way for banks to package leveraged loans together to provide investors with an investment vehicle with varied degrees of risk and return to best suit their investment objectives. The assets are typically senior secured loans, which benefit from priority of payment over other claimants in the event of an insolvency. Put simply, a CLO is a portfolio of predominantly leveraged loans that is securitized and managed as a fund. In spite of this, we believe CLOs are attractive investments and well worth the time and effort required to understand them. But for many investors, the basics of how they work, the benefits they can provide, and the risks they pose are wrapped in complication, which is why they’re also often misconstrued by the financial media and some market participants. They have historically offered a compelling combination of above-average yield and potential appreciation. CLOs have been gaining wider prominence in markets in recent years, and it’s no surprise why.
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